No Longer the Dumb Money

On April 22, 2016, Caisse de dépôt et placement
du Québec made a striking announcement. The
Montreal-based investor, which has managed public pension and
insurance assets since 1965, revealed ambitious plans to build,
own, and operate a C$5.5 billion ($4.2 billion), 42-mile,
24-station light-rail system in its home city. Whats
more, the pension manager unveiled an innovative scheme to pay
for the project: Rather than follow the usual infrastructure
financing road map, in which public pension funds and
established infrastructure managers invest together in, say, an
airport or a highway, Caisse, with C$255 billion under
management, would invest a stunning C$3.3 billion of its own
assets in the rail system, with the rest of the money coming
from the province of Quebec and the Canadian federal
government.

Its never been done before, Caisse CEO Michael Sabia says of what he calls a
public-­public partnership. It is also the debut project of
new Caisse investment subsidiary CDPQ Infra, which was designed
to follow the lead of the pension managers real estate
unit, Ivanhoé Cambridge.

The bold move is the latest in a series of major overhauls
enacted by Sabia since he joined the pension in March 2009,
after the global financial crisis had blown a C$40 billion hole
in the pension managers portfolio  a full quarter
of its assets. Desperate for a turnaround, thenQuebec
premier Jean Charest charged Sabia with transforming the fund
into an investment machine that could withstand market shocks.
The move was both audacious and unpopular, as there had never
been a native-­English speaker leading Caisse and Sabia did
not have an asset management background. But the new CEO, who
is fluent in French, was undaunted and immediately put an
ambitious plan into place that included firing both employees
and external asset managers, simplifying an overly complex
portfolio, changing the organizations culture and
mind-set, and restructuring its three real estate
subsidiaries.

The launch of CDPQ Infra is the latest manifestation of
Sabias vision. Although Canadian pension funds, such as
the Ontario Teachers Pension Plan and the Ontario
Municipal Employees Retirement System, are well known for
directly copurchasing highways and rail lines  including
the 68-mile rail link between London and the Channel Tunnel
 these are so-called brown-field investments: They target
buildings, highways, and ports that have already been built and
need rehabilitation. None has taken on a large,
start-from-scratch green-field building project because of the
risks of such an undertaking. I would say its
pretty rare, agrees Yvan Breton, a partner in
Mercers Canadian wealth management business and the
firms head of fiduciary management in Canada.

Its also risky, some experts say. Its a
very complex and hazardous asset class, warns Roger
Urwin, global head of investment content for advisory firm
Willis Towers Watson. He estimates that global infrastructure
investments total between $500 billion and $1 trillion. Only 3
to 5 percent of the worlds pension funds regularly
allocate to the asset class. And as the worlds largest
pensions join infrastructure managers in seeking the best
opportunities, the field is getting crowded.

Sabia sees it differently. For starters, he believes 
as do many in the investment world  that in the future
traditional equity and bond markets will not deliver the
returns necessary to fund pension liabilities. More and
more, you just want to take asset risk, Sabia says.
Markets arent going to pay much, despite the
effervescence in the market post-Trump.

More important, Sabias decision to step up
infrastructure investing and create a subsidiary business to
build, own, and operate projects was born of his deep
conviction that operations are a source of value. Unlike most
pension fund executives, who typically spend their careers in
pension management or on the asset management side, Sabia
served as CEO of Bell Canada International and CFO of Canadian
National Railway Co., and that experience contributed to his
belief in the importance of building long-term asset value
rather than reaping short-term investment returns.

You have to treat the principles of investing like an
industrial company, he asserts. Its in the
operations that you create durable value, not with financial
engineering.

Sabia has spent his career putting his philosophy into
action. He was born in St. Catharines, Ontario, in 1953, and
earned a BA in economics and politics from the University of
Toronto and graduate degrees in economics and politics from
Yale University. After working for the Canadian government as a
senior official in the Department of Finance and the Privy
Council Office, he joined government-owned Canadian National
Railway in 1993 and worked his way up to CFO. He facilitated a
financial turnaround at the company and helped take it public
in 1995.

In 1999, Sabia left for Bell Canada, the countrys
largest communications company; in 2002 he became CEO of its
parent, BCE, where he faced a different challenge: The
telecommunications business needed to change its approach to
the double threats of cable and the Internet as the dot-com
bubble was ending.

Sabias tenure at BCE came to an end in the heat of a
takeover battle between Ontario Teachers and U.S. private
equity firm KKR & Co. for control of the company, which the
pension plan eventually won. In 2008, Sabias job became a
casualty of the power struggle between the investors, but he
walked away with a cool $21 million bonus.

The timing was fortuitous. By early 2009 the devastated
Caisse, whose assets had sunk to C$120 billion, needed a new
CEO. After province premier Charest tapped Sabia for the job,
the appointment was officially made by the board of directors
and ratified by the Quebec government. It was then that Sabia
embarked on one of his biggest career challenges yet.

Just days after joining Caisse, Sabia stood
in the soaring, glass-­enclosed atrium of the pension
managers headquarters and addressed his new employees,
who had been badly shaken by the funds losses. The
lack of sense of pride inside the building was terrible,
recalls Macky Tall, CEO of CDPQ Infra. Employees, who
were traditionally proud to work here, were almost ashamed to
say they worked here.

Sabia broke the ice by saying he needed thenU.S.
president Barack Obama, a gifted speaker, to help him find the
right words for the occasion. Ive done other
things, but this is the biggest hour of my career, Sabia
told the employees. The Caisse is a great place filled
with great potential, and thats why I am here.

The new CEO drew inspiration from Caisses
headquarters, the Parquet, a cathedral-­like modern
structure built in 2003. The space symbolized the
potential of the institution that had lost C$40 billion,
he explains. It symbolizes ambition, what we can
accomplish.

Sabia needed plenty of inspiration as he set out to rebuild
the once-­revered pension manager. Hed taken over an
organization that was managing the assets of 25 mostly public
pension funds (it now manages 34) and insurance plans. The
largest of these are the Government and Public Employees
Retirement Plan, Fonds damortissement des régimes
de retraite, Fonds du Régime de rentes du Québec,
and a pension plan for the Quebec construction industry.

He faced tough challenges at the outset. I remember
quite vividly a day in late-April 2009 when I had to tell five
members of the executive committee that they didnt have a
future here, he says. Senior people had to go.
Its very rare you can get someone to do something
differently.

And Sabia definitely wanted his senior people to do things
differently, building on his philosophy of creating long-term
asset value. First and foremost, he asked employees to start
investing like an owner and to see their roles as
builders, not traders.

Because he believed he had waited too long to begin
housecleaning at both BCE and the Canadian railway, Sabia moved
fast, traveling to France to entice Roland Lescure, then deputy
CEO and CIO of Groupama Asset Management, to take on the CIO
job at Caisse. Starting in October 2009, Lescure began tackling
the job of portfolio simplification, and a new round of layoffs
and hirings began.

When I got here, the magic word was
diversification, the French-born former
government economist and asset manager explains. I called
it de-worsification: When you own a bit of everything, you
dont own anything. It took a lot of reprogramming of
people, a lot of change.

Caisses hedge fund portfolio, invested in 130
different funds, was a perfect example of overdiversification;
Lescure slashed it to 25 funds. When Sabia questioned the need
to invest in any hedge funds, Lescure told him that having
access to top asset managers market views would help him
understand activity in the markets. We learn about the
profession of asset management, says the CIO, who is also
co-head of the investment risk committee and serves on
Caisses executive committee. Theyre a window
on the world. These managers can also serve as a canary
in the coal mine when it comes to spotting crowded trades:
If all hedge funds are doing the same thing, we probably
shouldnt be doing it, Lescure says.